Balance risk through knowledge: Tyndall

Penny Chin

As the credit security market continues to flourish, investors are warned a lack of understanding of the risks associated with investing in non-government bonds could mean the potential benefits aren’t realised.

According to a newly-released Tyndall research paper, non-government bonds outstanding have increased more than tenfold in the past 10 years and with the ongoing growth of funds from superannuation, the demand for bonds is not expected to abate.

However, according to the paper’s author, Penny Chin, Tyndall’s senior credit analyst, investment in non-government bond issues adds a number of risks to a portfolio, including credit spread risk, downgrade risk and default risk.

Credit spread risk is the risk that the capital price of an obligation will underperform a government bond with the same maturity due to the increase of the interest rate spread for a risky bond over a riskless bond.

Downgrade risk is the risk that one of the ratings agencies reduces its credit rating on an issuer, signalling its belief that the credit quality of an issuer has deteriorated.

Default risk is the failure of a counterparty to meet a contractual debt obligation.

However, Chin added that understanding and managing the risks associated with credit securities could help investors realise the benefits, which include increased returns and greater diversification of fixed interest holdings and investments.

“Its management requires measurement of a number of risk factors, including the industry the issuer is in, its competitive position, its management and ownership and its financial risk,” Chin explained.

“Specialist bond fund managers have learned to adapt to the changed market by employing credit analysts to measure credit risk exposure, but it is a difficult and complex task for direct investors.”